Venture Capital

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Department of Urban and Regional PlanningWhy care?Some basics on venture capitalOf increasing interest to states, larger cities with emphasis on entrepreneurship and innovation Capital availability as a constant concern of start up businessesShift of political attention to start ups means capital questions front and centerInitial experimentation, by some jurisdictions, in VC support policies, programs What are the right policies and programs?Department of Urban & Regional Planning 2Venture capital definedMoney invested in new ventures and developing businesses More than money, synergy: A significant form of financial intermediation that provides privately held entrepreneurial firms with equity or hybrid forms of financing, in conjunction with managerial expertiseDifferences from traditional capitalVenture capitalLess fluid Requires high return rate Invested based on longerrun future Concerned with product and market potential Venture capitalist and partner are co-ownersTraditionalMore fluid Bears lower return Invested based on immediate future Concerned with past performance Loaning bank is creditorRequires collateralSource: Hosmer (1982)Department of Urban & Regional Planning3Department of Urban & Regional Planning4The role of VCEnables businesses that would not receive conventional bank funding to:Start-up (pre-seed) Expand (seed)Players in VC industryActorEntrepreneurRoleProvides innovative business ideaProfileLittle to no capital/business experience Commitment and preparation Knowledge and awareness Reasoned risk taker Ability to get things done Willingness to share ownership Friends/business partners of entrepreneur with high personal net worth Typically Invest less than $100,000 in the ventureTypically less developed, higher-risk entrepreneurial firms Entrepreneurs with innovative ideas, but no internal capital and no business track record Examples: SAS, Microsoft, Apple, Staples, TCBYAngelProvides initial money (mostly pre-seed), but no managerial serviceSource: Gompers (1994)Source: Barry (1994)Department of Urban & Regional Planning5Department of Urban & Regional Planning6Players contActorInvestorsVC investment processProfileIndividuals/Families (17%) Commercial and specialized banking firms/Insurance (18%) Corporate sponsors (2%) Pension funds (38%) Foundations/Endowments (22%) Other (3%) Experienced with going public, selling/merging a portfolio firm, liquidating unpromising deals, replacement of management Providing access to key needed expertiseRole (in Limited Partnership)Provide 99% of investment money Serves as limited partner (LP) Not allowed to be involved in dayto-day fund activities, but have some measures of controlRaise funds Identify options for investment Execute deal Monitor investmentsSell stake; achieve return on investmentVenture capitalistGeneral partner Contributes 1% of fund Responsible for deal origination, screening, evaluation & structuring as well as post-investment activitiesSource: Barry (1994)Source: Fried and Hisrich (1994)Department of Urban & Regional Planning7Department of Urban & Regional Planning8VC funding use at business stageStart up First stage Second stageVenture capital contracting problemsUncertainty the inability to predict future event Information asymmetry between entrepreneur and venture capitalist Agency costs uncertainty and information asymmetry mean the entrepreneur is in a position to take advantage of the VCProduct development and initial marketing Establishment of product or service in commercial use and generation of early sales Operational expansion coverage for a company with growing sales Funding for major expansion of a profitable company, or bridge financing for a firm expecting to soon go public Financing the purchase of a business for companies or management teamsSource: Walter (1985)Third stage+ Acquisition/buyoutDepartment of Urban & Regional Planning9Department of Urban & Regional Planning10Solution?IncentivesShift of control from the entrepreneur to VC Intense monitoring The emphasis on exit to recycle VC contributionsPublic sector rationale in VC?Capital perfectly mobile, available everywhere?Why might it not be?Department of Urban & Regional Planning11Department of Urban & Regional Planning12Boom & bust in VC marketWhat shifts VC market (supply/demand) Why is adjustment of VC industry slow, say to demand growth? Why does VC market have a tendency to overreact? What are the consequences of under- and overshooting? Appropriate government action?SourcesBinder, R A, and L A Yow,Venture capital: Do economic developers want a piece of the pie?, PowerPoint presentation, Department of Urban & Regional Planning, University of North Carolina at Chapel Hill, April 2001. Perez, R. 1986. Inside Venture Capital: Past, Present and Future. Praeger: New York. Amit, R., J. Brander, and C. Zott. 1998. Why do venture capital firms exist? Theory and Canadian experience. Journal of Business Venturing 13 (6). Hosmer, L. T. 1982. A Venture Capital Primer for Small Businesses. Washington, DC: Small Business Administration. Berlin, M. 1998. That thing that venture capitalists do. Federal Reserve Bank of Philadelphia Business Review, January/February, pp. 15-27. Gompers, P. 1994. The rise and fall of venture capital. Business and Economic History 23 (2). Walter, D. 1985. Venture Capital: Where to find it, How to go after it. Seattle, Washington: Venture Source Publishers. Barry, C. B. 1994. New directions in research on venture capital finance. Financial Management. 23 (3): 3-15. Fried, V. H. and R. D. Hisrich. 1994. Toward a model of venture capital investment decision making. Financial Management 23 (3): 28-37. Growing New Businesses with Seed and Venture Capital: State Experiences and Options. National Governors Association, 2000. 13 Department of Urban & Regional Planning 14Department of Urban & Regional Planning


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